On Lost Decades & Free Lunches

Figures from the ONS today show that between 2005 and 2011, UK disposable income per head dropped from being the 5th highest in the developed world to 12th.

Such figures are part of a larger picture emerging about the recent performance of the UK. In broad strokes the big picture of the UK since 2008 has been of a large fall in output, followed by a long period of stagnation that may finally be giving way to an incredibly weak recovery. We are, by most measures, underperforming both out own historical experience and the experience of other large developed economies.

The consequences of this performance can be seen in both the unprecedented decline in living standards and in the continued existence of a large public deficit.

As TUC research last week showed, using IMF figures the UK is truly set for a lost decade. GDP per capita (in real terms) will be no higher in 2017 than it was in 2008.

The poor comparative performance of the UK from circa 2010 to 2013 is especially clear – whilst other large economies show signs of recovery, the UK continues to flat line. Even the ‘recovery’ of 2014-2017 forecast by the IMF is relatively weak in comparison to other countries.

Faced with such grim economic prospects, the response of many is to simply shrug their shoulders, announce that there is no alternative and focus on ‘dealing with our debts’.

This is to put the cart before the horse. The lesson of history is not that reducing your deficit boosts your growth, but that increasing your growth reduces your deficit.

Even if you choose to make ‘dealing with the debt’ a priority (and in the current circumstances of a demand constrained, weak economy that is a mistake – as even Rogoff and Reinhart now admit) then there are still options.

Yesterday the TUC and NIESR published an important research paper (commissioned by the TUC and carried out by NIESR) on the macroeconomics of government infrastructure spending.

The report (which can be read in full here) found that infrastructure spending in crisis times can boost growth in the both the short and long run and lower unemployment. This will come as no surprise to many, but perhaps the most interesting finding was that:

While the short-run impact is an increase in the deficit, over the long run there may be a reduction in the debt-GDP ratio.

In other words, spending on infrastructure (assuming some positive external effects and that the economy is depressed – neither of which are heroic assumptions) could easily result in a lower debt/GDP ratio, not a higher one. We get the boost to growth, we get lower unemployment, we get the additional infrastructure and it ultimately pays for itself.

This is a close to a “free lunch” as macroeconomic policy makers will ever get. In the context of an economy ambling through a lost decade it would be madness not to seize this chance.

Written by Duncan Weldon

Duncan Weldon was a Senior Policy Officer in the Economic and Social Affairs Department covering macroeconomics and regional policy. Before joining the TUC he had a fairly varied career taking in the Bank of England, fund management, the Labour Party…

[…] Putting this all together brings us to some extremely useful research by NIESR (funded by the TUC) earlier this year. They found that a capital spending stimulus, funded by additional borrowing, if done when the economy remained depressed (e.g. When there is a substantial output gap) and assuming some positive long run impact of more infrastructure (not especially heroic assumptions!) then the impact would be not just higher growth and lower employment in the short run but also a lower debt/GDP ratio in the medium term. In other words if done at the right point in the cycle, then more capital spending means more infrastructure, higher demand, lower unemployment, faster growth and a better debt/GDP ratio. As I noted at the time, this is as close to a free lunch as macroeconomists are ever likely to get. […]

[…] Putting this all together brings us to some extremely useful research by NIESR (funded by the TUC) earlier this year. They found that a capital spending stimulus, funded by additional borrowing, if done when the economy remained depressed (e.g. When there is a substantial output gap) and assuming some positive long run impact of more infrastructure (not especially heroic assumptions!) then the impact would be not just higher growth and lower employment in the short run but also a lower debt/GDP ratio in the medium term. In other words if done at the right point in the cycle, then more capital spending means more infrastructure, higher demand, lower unemployment, faster growth and a better debt/GDP ratio. As I noted at the time, this is as close to a free lunch as macroeconomists are ever likely to get. […]